Narrative Recap: Ethereum's Coming of Age

Tornado Cash was arguably the most well-known privacy tool in the crypto world, allowing users to transfer funds anonymously by sending set amounts of tokens in pooled transactions. By sanctioning the smart contract, the US Government claims to crack down on criminal activities, but ultimately limits the financial privacy of law-abiding citizens.

What came as a bigger surprise to much of the crypto community was the wholesale cooperation of Circle, the stablecoin issuer responsible for USDC. Quickly banning the contracts associated with Tornado cash, the organization went one step farther and blacklisted a number of wallets that had interacted with the protocol in the past.

The move was widely decried, with many drawing parallels to the United States’s decision to deny Russia access to their own assets in the wake of the invasion of Ukraine. MakerDAO publicly expressed interest in moving their DAI stablecoin away from USDC backing in response.

The outlook for privacy and permissionlessness on the blockchain deteriorated further with the arrest of a 29-year old developer in the Netherlands for his suspected involvement in Tornado Cash’s creation. All in all, these developments were cause for concern about the safety of operating on-chain, and many saw the events as a sign of crypto’s increasing susceptibility to centralization risk.

It’s hard not to view these developments in the context of this week’s other major topic of conversation: the massive upgrade of the Ethereum network that will follow the proof-of-work network’s merge with the Beacon Chain. With a proof-of-stake L1 employing data sharding to store data, combined with an increasing reliance on L2s to validate transactions, Ethereum is presumed to be on the eve of a massive expansion of its ecosystem. The network currently processes about 20 transactions per second, but but founder Vitalik Buterin foresees a rise in throughput to over 100,000 tps once Ethereum’s roadmap is complete.

Massive amounts of investment and developer activity have poured into Ethereum in the months leading up to the merge, and there is a general sense that the smart contract platform is on the cusp of leveling up, as we have long taken for an inevitability. A strong testament to this belief came from the tradfi world when the CME Group decided to launch options on ETH futures beginning on September 12th. With options typically used as a means of hedging directional exposure, the decision to offer contracts on the world’s leading derivatives marketplace belies a strong belief that the volume of ETH trading will only increase following the mid-September upgrade.

One major component of this upgrade is the transition to Layer 2 solutions shouldering Ethereum’s execution layer, and the rapid growth of rollup ecosystems seems to have happened before our eyes this summer. Earlier this week, Yearn Finance, Iron Bank, and Homora joined the Optimism ecosystem in a move to take advantage of its higher scalability and lower transaction costs. No less significant was the decision by Lido to integrate with Argent to bring stETH to L2s. With this new functionality, users will be able to stake ETH and secure the mainnet without ever taking their tokens off of a layer 2 network.

Finally, over the past few weeks, the DeFi world continued to speculate enthusiastically on the burgeoning field of Real World Asset lending. With the advent of RWA lending, we have begun to see DeFi creep in around the corners of traditional finance, providing liquidity to underserved markets and higher returns to investors who would not ordinarily have access to them. Don’t forget, it was always the goal for DeFi to take market share away from tradfi in arenas like these, and what we are witnessing is nothing short of that process beginning to unfold as network scalability allows for greater adoption.

One important conclusion can be drawn from these disparate phenomena: that as DeFi’s network capacity expands, it will be capable of integrating larger portions of the global economy on-chain and thus present legitimate security threats to financial systems and state governments. We can only assume that increased adoption of this nature will be met in every case with increased regulation.

The crypto world has shed much of the language of its early years, when transactions were conducted like drug deals off of LocalBitcoins.com and forum messages were rife with Alex Jones quotes. Anyone who was around back then, however, remembers the general tenor of conversation. This entire experiment was designed to wrest control of our financial lives away from centralized entities, with their capacity to censor and blacklist at their own discretion.

In a Faustian bargain, these ideological overtones have largely fallen to the wayside, and the fact that this occurred exactly as crypto went mainstream seems like no coincidence. The stories this week could represent the latest in the true overarching narrative: that while tradfi might look a bit more like DeFi with each passing year, DeFi will likely look a bit less like DeFi. The seeds of a true, decentralized, permissionless financial system may yet exist in the world of crypto, but with each step towards integration with the wider world, it seems a bit less like Ethereum will be its home.